Lumpy Capacity Investment and Disinvestment Dynamics

Capacity addition and withdrawal decisions are among the most important strategic decisions made by …rms in oligopolistic industries. In this paper, we develop and analyze a fully dynamic model of an oligopolistic industry with lumpy capacity and lumpy investment/disinvestment. We use our model to suggest answers to two questions. First, what economic factors facilitate preemption races? Second, what economic factors facilitate capacity coordination? With a series of examples we show that low product di¤erentiation, low investment sunkness, and high depreciation tend to promote preemption races. The same examples also show that low product di¤erentiation and low investment sunkness tend to promote capacity coordination. Although depreciation removes capacity, it may impede capacity coordination. Finally, our examples show that, at least over some range of parameter values, …rms’ expectations play a key role in determining whether or not industry dynamics are characterized by preemption races and capacity coordination. Taken together, our results suggest that preemption races and excess capacity in the short run often go hand-in-hand with capacity coordination in the long run. We thank Ron Borkovsky, Je¤ Campbell, Jiawei Chen, Steve Kryukov, Ken Judd, and an anonymous referee for helpful comments and discussions. Besanko and Doraszelski gratefully acknowledge …nancial support from the National Science Foundation under Grant No. 0615615. Satterthwaite acknowledges gratefully that this material is based upon work supported by the National Science Foundation under Grant No. 0121541. yKellogg School of Management, Northwestern University, Evanston, IL 60208, [email protected]. zDepartment of Economics, Harvard University, Cambridge, MA 02138, [email protected]. xKenan-Flagler Business School, University of North Carolina, Chapel Hill, NC 27599, [email protected]. {Kellogg School of Management, Northwestern University, Evanston, IL 60208, [email protected].